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Revolving credit card debt is a common problem for people across all income ranges. People who have ample income and can easily meet their minimum payments often don’t think twice about what its really costing them in wealth.
In fact, keeping a balance on your credit cards is probably costing you much more than you think. Not only does it cost you in interest payments, but also an opportunity cost of not investing the funds you paid in interest.
What is Revolving Debt?
Revolving debt is a credit line that allows you to borrow again after you pay off the principal (or original amount your borrowed), up to the max amount of your credit line. Its revolving because you can borrow on it over and over again.
Credit cards fall into the revolving debt category because you can borrow from the credit card company over and over again, up to the maximum allowed on your credit line.
This differs from an installment loan, in which you borrow a one-time amount and then pay it off in fixed installment payments. Once you pay down the principal, you can’t re-borrow on an installment loan.
Case Study on Revolving Credit Card Debt
In order to demonstrate the issue, let’s examine a case study of Jillian and Judy to compare how they handle their use of credit cards, and what the true cost/benefit is to their wealth profiles.
Carrying balances on your credit cards is expensive.
Jillian is our big spender. She loves to shop. She carries four credit cards, with balances that add up to a total of $10,000. Here’s her revolving credit card profile:
Jillian pays just $170.42 in interest every month, and she also pays a few hundred extra dollars in payments on each card, making her feel like she’s paying down her debt. However, she uses her cards to make new purchases every month, and the actual balance hasn’t budged in a while.
If Jillian continues to keep the same spending habits, she will pay over $10,225 in interest expense over the next 5 years, and $40,900 over the next twenty years.
BAD DEBT IS DEBT THAT MAKES YOU POORER.
-Robert Kiyosaki
The Opportunity Cost of Revolving Credit Card Debt
Meanwhile, Jillian’s sister Judy has no credit card debt, and is depositing $170.42 into her brokerage account every month. She’s saving for financial freedom, and plans to use the funds to help her buy rental property in the future.
For now, its invested in the market and she earns an average of 8% per year on her investment. Judy saves much more than $170.42 per month, but we will use that amount to demonstrate the total cost of Jillian’s spending habits.
What to do if you have Revolving credit card debt
If you’re currently carrying credit card debt, your best option is to pay it off as quickly as possible. Don’t worry about saving money until its paid off (except for some emergency cash). Pour all of your extra dollars into paying it down, and get your balances to $0.
Create your own debt profile, like Jillian’s. Here’s a free worksheet in Excel:
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Decide which you want to pay first – target either
Lowest balance cards
Highest interest rate
Calculate how much you can spend paying down your cards
Create a budget
Reduce your cost of living
Sell stuff around the house on Ebay, Facebook marketplace, or Craigslist
Now the fun part – calculate how much you’ll be able to save and invest after your revolving credit card debt is gone.
Stay focused on your goals by tracking your progress every month. Create a chart and show your monthly balances decreasing. This is an exciting process!
Remember – every time you make a principal payment on your revolving credit card debt, you’re increasing your net worth.
Is it ever okay to use credit cards?
Yes, its okay to use credit cards to make purchases that you can pay off in the same month. As a general rule, never buy anything with a credit card that you can’t pay for in cash.
Here are three reasons to use credit cards for a positive effect on your financial outlook:
Credit cards increase your credit score by building a credit history.
Some credit cards offer rewards, like points for travel, cash back, or other rewards.
Credit cards can be used at hotels and other venues to secure a deposit without having to use actual cash.
As a general rule, never buy anything with a credit card that you can’t pay for in cash.
However, none of the above reasons result in a positive gain if you don’t pay your credit card balances in full each month.
Do you use credit cards in positive or negative ways?
And like other types of credit, consistently using revolving credit responsibly could have a positive impact on your credit scores. But keep in mind that using too much of your available credit could negatively affect your scores.
Consolidating your debt can be a strategic move to improve your financial health and free up resources for wealth-building opportunities. By combining multiple debts into a single loan, you can often secure a lower interest rate and reduce your overall monthly payments.
Overall, the national average card debt among cardholders with unpaid balances in the fourth quarter of 2023 was $6,864, down from $6,993 in the third quarter. That includes debt from bank cards and retail credit cards.
Credit cards are a common source of revolving credit, as are personal lines of credit. Not to be confused with an installment loan, revolving credit remains available to the consumer ongoing.
The key benefits to revolving credit include access to credit whenever you need it, and the ability to build and maintain a positive credit history to qualify for lower interest rates on personal loans or a mortgage. The main risk to revolving credit is taking on more debt than you can repay.
Credit cards often have high interest rates when compared with other types of credit. The higher your revolving balance, the more interest you'll pay on any balance you carry over. Depending on your balance, your minimum payment can also be high.
Ninety-three percent of millionaires said they got their wealth because they worked hard, not because they had big salaries. Only 31% averaged $100,000 a year over the course of their career, and one-third never made six figures in any single working year of their career.
Millionaires earn valuable rewards by using credit cards, from paying for groceries to buying clothing. For example, some cards offer 5% cash back on certain purchases, or you could earn points or airline miles that can be redeemed for gift cards or travel.
New York Federal Reserve: Gen Z Has Largest Percentage of Credit Card Debt. A growing number of Americans are maxed out on credit cards, with Gen Z leading the way, The Washington Post reported, citing a new report from the Federal Reserve Bank of New York.
High-interest credit card debt can devastate even the most thought-out financial plan. U.S. consumers carry $6,501 in credit card debt on average, according to Experian data, but if your balance is much higher—say, $20,000 or beyond—you may feel hopeless.
$5,000 in credit card debt can be quite costly in the long run. That's especially the case if you only make minimum payments each month. However, you don't have to accept decades of credit card debt. There are a few things you can do to pay your debt off faster - potentially saving thousands of dollars in the process.
Revolving lines of credit generally come with higher interest rates than installment loans. That's particularly true if the line of credit is unsecured. It's limited. Typically, the credit limit on a line of credit is smaller than an installment loan.
This repayment strategy, sometimes called the avalanche method, prioritizes your debts from the highest interest rate to the lowest. First, you'll pay off your balance with the highest interest rate, followed by your next-highest interest rate and so on.
Generally, credit card debt refers to the accumulated outstanding balances that many borrowers carry over from month to month. Credit card debt can be useful for borrowers seeking to make purchases with deferred payments over time. This type of debt does carry some of the industry's highest interest rates.
Yes.A revolving loan facility is a loan, just like any other term loan. The difference is that instead of receiving borrowed money in a lump sum, the money can be used as needed, repaid, and then used again.
Revolving credit, particularly credit cards, can certainly hurt your credit score if not used wisely. However, having credit cards can be great for your score if you pay attention to your credit utilization and credit mix while building a positive credit history.
Debt could also be considered "bad" when it negatively impacts credit scores -- when you carry a lot of debt or when you're using much of the credit available to you (a high debt to credit ratio). Credit cards, particularly cards with a high interest rate, are a typical example.
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